Ex-Citigroup Chairman John Reed: No More Wheel of Fortune

(MoneyWatch)  Former Citigroup (C) chairman John Reed recently made a vital, and often overlooked, point explaining why allowing huge financial companies to mix traditional banking services with riskier activities is dangerous -- it turns them into gamblers.

Proprietary trading, hedge fund investment and related businesses "bring with them their own culture," Reed told Senate lawmakers at a Feb. 4 hearing to discuss Paul Volcker's proposed bank reforms:

These are cultures that have to exist for a particular purpose, but they have their own particular characteristics, and there is no question in my mind that these cultures have an impact on the institution within which they're embedded. And if I were asked to design a system, I would not allow these kind of cultures and activities to be a part of large depository and traditional lending institutions.

It's not that I feel these functions shouldn't exist. I would simply separate them from institutions that are the deposit-takers and basically the traditional lenders for much of the economy. And I do this because I think that culture from the capital markets... has to do with risk-taking. It certainly has to do with compensation, and it has to do with the nature of the human fabric of the various entities that we're talking about.

Bravo to Mr. Reed, who of late has made a habit of telling it like it is. Yes, prop trading represents a small fraction of what companies like Bank of America (BAC), Citigroup (C) and JPMorgan Chase (JPM) do. Agreed, the existence of hedge funds within lenders didn't in and of itself cause the financial crisis.

But it does encase a speculator's mentality, a taste for action, within companies that historically have put a premium on husbanding, not betting, their resources. The most obvious example is AIG (AIG) and its infamous financial products group. But as Reed said in his testimony (no link available), the problem is endemic.

For banks, the good news is that these trading activities account for a tiny percentage of their business; for example, only one percent of B of A's revenue comes from prop trading. Impounding their roulette wheels shouldn't hurt too badly.